Why Central Bank Swaps Haven’t Put a Stop to LIBOR’s Climb

Defying most investors’ expectations, LIBOR’s climb has continued unabated, despite the reopening of the Fed’s Reciprocal Currency Swap lines.    According to the ECB’s records on May 11^th seven bidders tapped USD9.2bn of the swaps at a rate of 1.22%, or nearly 100bps above the OIS funding rate.  Ray Stone of Stone & McCarthy Research Associates, may have the best explanation I have been able to find as to why LIBOR has been unaffected by the Fed’s announcement.  In short Ray says that the liquidity provided by the central banks will be available at ‘fixed rates’ that is set ‘roundly 100bps over the OIS funds rate, or equivalent, setting up a penalty rate similar to the Fed’s discount rate.  Ray believes this penalty rate will act as a ceiling on LIBOR, which according to my calculations would presently put a 1.22% cap on 3M LIBOR, compared to a current rate of 0.460%.  Therefore, the mechanisms significant penalty over traditional interbank funding (LIBOR) ‘accounts for lack of impact on underlying money market conditions’.

3M LIBOR vs 3M Treasury